Some bonds allow prepayment, others don't

Among capital-appreciation school bonds that have become controversial across California, some allow prepayment as an escape hatch and others do not.

The bonds generally allow school districts to pay nothing for decades, then require large balloon payments with accrued interest that can eventually cost more than $10 for every dollar borrowed.

The Watchdog reviewed the five local bond deals with the least favorable debt ratios and found that three of them ban prepayment. Two of them do offer prepayment, an option that could reduce interest costs down the road.

The Santee School District, Southwestern College and Poway Unified School District all are locked into the long-term interest costs on the bonds. Oceanside Unified and San Ysidro School District can prepay most of their bonds if they come up with the money.

Santee has the least favorable debt ratio in the county, according to a statewide database compiled by the Los Angeles Times, with its borrowing of $3.5 million in 2011 that will cost $58.6 million to pay back over the life of the bonds. The deal allows no prepayment.

Southwestern Community College District borrowed $10.4 million bond in 2011, which will end up costing taxpayers $116.1 million. That deal also lacks a prepayment option.

Poway Unified School District’s deal to borrow $105 million at a cost of $981.6 million also carries no prepayment option.

Southwestern and other districts suggested looking at the capital bond deals in the context of their overall borrowing programs.

“Southwestern College has always looked for the best combination of financing that would be the most cost effective for taxpayers. This particular financing combination ensures taxpayers are not paying anything more than 3.3 times the original amount financed,” Southwestern Spokeswoman Lillian Leopold said. “That is considerably lower than the repayment amount of a conventional home mortgage.”

San Diego Unified School District issued $88.9 million in capital-appreciation bonds in 2010 that will cost $630.4 million by the time they are paid off in 2047, also with no prepayment option.

Other districts have structured their borrowings differently, allowing for prepayment of their bonds decades before they mature, including the bonds issued by the San Ysidro School District in 2011. The $15.6 million in bonds mature in 2050 at a maximum repayment cost of $228.9 million, or $14.68 for every $1 borrowed.

All but $580,000 of San Ysidro’s bonds can be prepaid without any penalty in 2023, an option that, if taken, could save taxpayers millions of dollars.

San Ysidro school board member Jean Romero said she hopes the district’s future school board members and administrators take the prepayment option, and reiterated that there are no penalties for doing so.

“What we’re anticipating is that the tax base for the homes in that area will rise with new construction and with hopefully the economy getting better and that we will be able to afford to prepay,” Romero said. “If we can pay it ahead of time, it would benefit everyone. It just makes good economic sense. So, hopefully we’re able to do that.”

While providing an option for prepayment may end up saving taxpayer money in the long run, if a district does not exercise the option it can end up costing taxpayers more. This is because bond investors look less kindly on bonds that may be redeemed before maturity. Asked if the bonds are harder to sell when they have a call option, San Diego County Treasurer-Tax Collector Dan McAllister said that is one way of looking at it.

“But there’s another side of it, for creating options for your board and future boards. It’s a good thing to do, because you’ve created an option to allow you to roll it into a refinancing along the way,” McAllister said. “You’re giving your board and your taxpayers options. By locking it in you’re giving them limited or no options.”

McAllister’s office has been a proponent of state legislation that would curtail use of such bonds and has assisted local elected officials in better understanding their faults. Like Southwestern College, other districts have described their capital bonds in the context of their larger bond deals to show the overall cost to taxpayers. McAllister said doing so prevents the public from learning about the capital bonds’ high cost.

“The whole notion of trying to average the bond portfolio tends to be, at least from what we’ve seen, to be some sort of a smoke-screen to hide the higher payback ratio items in those portfolios,” McAllister said. “That’s something that is disturbing.”

Another of the costliest San Diego County bond deals is the one issued by the Oceanside Unified School District in 2010, which does offer a prepayment option. The $30 million deal will cost taxpayers $279.7 million over 39 years if it is not prepaid. About half of the bonds can be prepaid or refinanced with no penalty starting in 2020.

Oceanside Associate Superintendent Luis Ibarra said the district wanted a prepayment option because the district wants flexibility. He said community input led to the decision and it wasn’t the first district bond to include the option.

“The callable feature will provide the district with the flexibility to restructure the debt in the future,” Ibarra said. “This flexibility has served us well in refinancing prior bond issuances at much lower interest rates thereby passing on the savings to the taxpayers of Oceanside.”